CAPITAL LEASE FUNDING INC - 10-K Annual Report

Index to Financial Statements

and Financial Statement Schedules


Report of Independent Registered Public Accounting Firm	58

Consolidated Balance Sheets as of December 31, 2004 and 2003	59

Consolidated Income Statements for the years ended December 31, 2004, 2003 and 2002	60

Consolidated Statements of Changes in Stockholders’ Equity/Members’ Capital for the years ended December 31, 2004, 2003 and 2002	61

Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002	62

Notes to Consolidated Financial Statements	63

Schedule III - Schedule of Real Estate and Accumulated Depreciation at December 31, 2004	85

Schedule IV - Schedule of Mortgage Loans on Real Estate at December 31, 2004	87

Report of Independent Registered Public Accounting Firm

To the Stockholders of

Capital Lease Funding, Inc.

We have audited the accompanying consolidated balance sheets of Capital Lease Funding, Inc. and subsidiaries (the “Company”) as of December 31, 2004 and 2003 and the related consolidated statements of income, stockholders’ equity/members’ capital, and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedules listed in the Index at Item 8. These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Capital Lease Funding, Inc. and subsidiaries at December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

		/s/ Ernst & Young LLP

New York, New York March 8, 2005 except for Note 22, as to which the date is March 10, 2005

Capital Lease Funding, Inc. and Subsidiaries

Consolidated Balance Sheets

As of December 31, 2004 and 2003

(in thousands)	As of December 31,
		2004			2003
Assets

Cash and cash equivalents	$	30,721		$	6,522
Mortgage loans held for sale		–			71,757
Mortgage loans held for investment		207,347			–
Real estate investments, net		194,541			–
Securities available for sale		87,756			40,054
Structuring fees receivable		4,426			5,223
Real estate investments consolidated under FIN46		48,000			–
Prepaid expenses and other assets		7,941			1,962
Amounts due from affiliates and members		81			44
Accrued rental income		507			–
Derivative assets		42			–
Furniture, fixtures and equipment, net		340			211
Total Assets	$	581,702		$	125,773

Liabilities and Members' Capital/Stockholders' equity

Accounts payable and accrued expenses	$	3,479		$	2,635
Deposits and escrows		10,725			175
Due to servicer and dealers		4,357			347
Repurchase agreement obligations		133,831			28,765
Repurchase agreement obligation due to affiliates		–			59,322
Mortgages on real estate investments		111,539			–
Derivative liabilities		7,355			484
Intangible liabilities on real estate investments		7,028			–
Dividends payable		4,124			–
Mortgage on real estate investments consolidated under FIN46		4,815			–
Total Liabilities		287,253			91,728
Minority interest in real estate investments consolidated under FIN46		41,185			–
Commitments and contingencies		–			–
Stockholders' equity/members' capital:
Preferred stock, $.01 par value, 100,000,000 shares authorized, no shares issued and outstanding at December 31, 2004		–			–
Common stock, $0.01 par value, 500,000,000 shares authorized, 27,491,700 shares issued and outstanding at December 31, 2004		275			–
Additional paid in capital		253,437			–
Accumulated other comprehensive income		1,203			–
Deferred compensation expense		(1,651	)		–
Retained earnings		–			–
Members' capital		–			34,045
Total Stockholders' Equity/Members' Capital		253,264			34,045
Total Liabilities and Stockholders' Equity/Members' Capital	$	581,702		$	125,773

See notes to consolidated financial statements

Capital Lease Funding, Inc. and Subsidiaries

Consolidated Income Statements

For the years ended December 31, 2004, 2003 and 2002

(in thousands, except per share data)		Year ended December 31,
		2004		2003		2002
Revenues:
Interest income from mortgage loans and securities	$	13,589	$	7,317	$	8,092
Gain on sales of mortgage loans and securities		794		11,652		10,051
Rental revenue		4,287		–		–
Property expense recoveries		1,608		–		–
Other revenue		726		151		343
Total revenues		21,004		19,120		18,486
Expenses:
Interest expense		2,768		1,220		2,142
Interest expense to affiliates		–		838		659
Property expenses		1,761		–		–
Net loss on derivatives and short sales of securities		724		3,129		7,729
Loss on securities		247		–		–
General and administrative expenses		8,833		7,186		6,966
General and administrative expenses-stock based compensation		3,825		–		–
Depreciation and amortization expense on real property		1,281		–		–
Loan processing expenses		196		114		158
Total expenses		19,635		12,487		17,654
Income before provision for income taxes		1,369		6,633		832
Provision for income taxes		9		–		–
Net income	$	1,360	$	6,633	$	832
Earnings per share (pro forma for 2003 and 2002)
Net income per share, basic and diluted	$	0.06	$	1.61	$	0.20
Weighted average number of common shares outstanding, basic and diluted		22,125		4,108		4,108
Dividends declared per common share	$	0.25	$	–	$	–

See notes to consolidated financial statements

Capital Lease Funding, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity/Members’ Capital

For the years ended December 31, 2004, 2003 and 2002

		Capital Lease Funding, LLC						Capital Lease Funding, Inc.
(in thousands)		Members' Capital			Accumulated Other Comprehensive Income (Loss)			Common Stock at Par		Additional Paid-In Capital			Accumulated Other Comprehensive Income (Loss)			Deferred Compensation Expense			Retained Earnings (Deficit)			Total
Members' capital at December 31, 2001	$	24,492		$	574		$	–	$	–		$	–		$	–		$	–		$	25,066
Net income for the year ended December 31, 2002		832			–			–		–			–			–			–			832
Unrealized change in value on securities available for sale		–			1,877			–		–			–			–			–			1,877
Members' capital at December 31, 2002		25,324			2,451			–		–			–			–			–			27,775
Net income for the year ended December 31, 2003		6,633			–			–		–			–			–			–			6,633
Unrealized change in value on securities available for sale		–			(363	)		–		–			–			–			–			(363	)
Issurance of stock-founders' shares		–			–			1		13			–			–			–			14
Members' capital at December 31, 2003	$	31,957		$	2,088		$	1	$	13		$	–		$	–		$	–		$	34,059
Acquisition of Caplease LP		(31,957	)		(2,088	)		40		31,917			2,088			–			–			–
Issuance of stock-initial public offering		–			–			230		241,270			–			–			–			241,500
Initial public offering costs		–			–			–		(19,723	)		–			–			–			(19,723	)
Issuance of stock-incentive stock plan at offering date		–			–			4		4,026			–			(2,669	)		–			1,361
Adjust initial management share purchases to market value		–			–			–		1,447			–			–			–			1,447
Incentive stock plan compensation expense-March 25- December 31, 2004		–			–			–		–			–			1,018			–			1,018
Net income		–			–			–		–			–			–			1,360			1,360
Dividends declared		–			–			–		(5,513	)		–			–			(1,360	)		(6,873	)
Unrealized change in value on securities available for sale		–			–			–		–			8,121			–			–			8,121
Unrealized loss on derivatives		–			–			–		–			(7,312	)		–			–			(7,312	)
Net realized loss on cash flow hedges		–			–			–		–			(1,694	)		–			–			(1,694	)
Balance at December 31, 2004	$	–		$	–		$	275	$	253,437		$	1,203		$	(1,651	)	$	–		$	253,264

See notes to consolidated financial statements

Capital Lease Funding, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the years ended December 31, 2004, 2003 and 2002

(in thousands)		Year ended December 31,
		2004			2003			2002
Operating activities
Net income	$	1,360		$	6,633		$	832
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Depreciation and amortization		1,386			150			121
Amortization of stock based compensation expense		3,825			–			–
Gain on sale of mortgage loans and securities		(794	)		(11,652	)		(10,051	)
Change in provision for loss on mortgage loans		–			(1,917	)		(83	)
Loss on derivatives and short sales of securities		724			3,129			7,729
Change in accrued rental income		(507	)		–			–
Changes in operating assets and liabilities:
Proceeds from sale of mortgage loans		–			159,915			154,327
Net principal advanced to borrowers		–			(141,185	)		(137,572	)
Funds used in hedging and risk management activities		(4,462	)		(4,219	)		(7,866	)
Loan origination costs		–			(61	)		(354	)
Securities held for sale		–			(20,175	)		(4,363	)
Structuring fees receivable		797			(429	)		437
Amounts due from dealers for short sales of securities		–			–			12,402
Short sale of securities		–			–			(11,266	)
Prepaid expenses and other assets		(7,018	)		(957	)		219
Accounts payable and accrued expenses		843			602			(245	)
Deposits and escrows		10,550			(515	)		(195	)
Due to servicer and dealer		4,012			(62	)		(298	)
Net cash provided by (used in) operating activities		10,716			(10,743	)		3,774

Investing activities
Proceeds from sale of mortgage loans		25,422			–			–
Principal advanced to borrowers		(167,009	)		–			–
Principal received from borrowers		8,520			–			–
Loan origination costs		331			–			–
Purchase of securities available for sale		(95,449	)		–			–
Sale of securities available for sale		55,868			–			–
Purchases of real estate investments		(174,605	)		–			–
Deposit on potential equity investment		(2,500	)		–			1,000
Purchases of furniture, fixtures and equipment		(234	)		(69	)		(154	)
Net cash (used in) provided by investing activities		(349,656	)		(69	)		846

Financing activities
Borrowing under repurchase agreements		135,411			47,974			84,034
Repayments under repurchase agreements		(30,344	)		(71,103	)		(107,549	)
Borrowing under repurchase agreements to affiliates		–			62,865			15,657
Repayments under repurchase agreements to affiliates		(59,322	)		(27,765	)		(2,684	)
Borrowings from mortgages on properties		97,547			–			–
Repayments of mortgages on properties		(198	)		–			–
Net proceeds from equity offering		222,818			–			–
Dividends paid		(2,749	)		–			–
Reverse merger		14			–			–
Repayments under notes payable		–			(275	)		–
Changes in amounts due from (to) affiliates and member		(38	)		252			(231	)
Net cash provided by (used in) financing activities		363,139			11,948			(10,773	)
Net (decrease) increase in cash		24,199			1,136			(6,153	)
Cash and cash equivalents at beginning of period		6,522			5,386			11,539
Cash and cash equivalents at end of period	$	30,721		$	6,522		$	5,386

Supplemental disclosure of cash flow information
Cash paid during the year for interest expense	$	2,647		$	2,176		$	2,574
Cash paid during the year for income taxes	$	–		$	89		$	64
Dividends declared but not paid	$	4,124		$	–		$	–

Supplemental disclosure of noncash operating, investing and financing activities
Prepaid expenses and other assets reclassified to public offering costs	$	1,040		$	–		$	–
Mortgage notes payable assumed on properties acquired	$	14,190		$	–		$	–
Value of in-place leases and above-market leases acquired	$	13,222		$	–		$	–
Value of below-market leases acquired	$	7,028		$	–		$	–
Real estate investments consolidated under FIN46	$	48,000		$	–		$	–
Mortgage on real estate investments consolidated under FIN46	$	4,815		$	–		$	–
Unrealized loss on cash flow hedges	$	7,312		$	–		$	–

See notes to consolidated financial statements

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

1.	Organization

Capital Lease Funding, Inc. (“CLF, Inc.” and collectively with its wholly-owned subsidiaries, the “Company”) was incorporated in the State of Maryland during October 2003, and was formed for the purpose of continuing the existing business operations and acquiring the assets and liabilities of Caplease, LP (“LP” or the Predecessor”). CLF, Inc. completed this acquisition through a reverse merger and its initial public offering during March 2004. The Company invests in real estate mortgage loans, equity interests in real estate properties, real estate securities and other real estate assets. The Company’s investments primarily consist of real estate related assets that are backed by commercial properties typically subject to long-term net leases from investment grade and near investment grade tenants.

The accompanying financial statements include the historical results of operations of the Predecessor prior to its acquisition by CLF, Inc.

The Predecessor’s principal activity was the origination and sale or securitization of commercial mortgage loans. Since 1995, the Predecessor was primarily engaged in the business of originating, underwriting and securitizing mortgage loans to owners of real properties subject to long term leases to high credit quality tenants. These loans were typically secured by a first lien on the leased property and an assignment of the leases and all rents due under the lease.

In March 2004, CLF, Inc. sold 23 million shares of its common stock in an initial public offering at a price to the public of $10.50 per share, for net proceeds of approximately $222 million. CLF, Inc. had 27,491,700 shares of common stock outstanding at December 31, 2004.

CLF, Inc. is organized and conducts its operations to qualify as a real estate investment trust ("REIT") for federal income tax purposes. As such, it will generally not be subject to federal income tax on that portion of its income that is distributed to stockholders if it distributes at least 90% of its REIT taxable income to its stockholders by prescribed dates and complies with various other requirements. On September 14, 2004, CLF, Inc. declared a dividend of $0.10 per common share, payable on October 15, 2004, to stockholders of record as of September 30, 2004. On December 20, 2004, CLF, Inc. declared a dividend of $0.15 per common share, payable on January 14, 2005, to stockholders of record as of December 31, 2004. The dividend declared in December was paid on January 14, 2005.

2.	Summary of Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying consolidated financial statements include the assets, liabilities, and results of operations of the Predecessor prior to March 24, 2004 and CLF, Inc. and its wholly-owned subsidiaries, thereafter. All significant intercompany transactions, balances and accounts have been eliminated in consolidation.

Use of Estimates

Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ from those estimates.

Risks and Uncertainties

In the normal course of business, the Company encounters primarily two significant types of economic risk: credit and market. Credit risk is the risk of default on the Company’s loans, leases and securities that results from a borrower’s, lessee’s or derivative counterparty’s inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of investments in loans and real estate or in hedging instruments due to changes in interest rates or other market factors, including the value of the collateral underlying loans and the valuation of real estate held by the Company. Management believes that the carrying values of its investments are reasonable taking into consideration these risks along with estimated collateral values, payment histories, and other borrower information.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Investments in Mortgage Loans

Mortgage loans are secured by an assignment of the long-term real property leases (the majority of whose tenants are investment grade) and mortgages on the underlying real estate. Mortgage loans held for investment are carried at cost (unpaid principal balance adjusted for unearned discount and deferred expenses), and are amortized using the effective interest method. Mortgage loans held for sale without a designated hedge are reported at the lower of cost (unpaid principal balance adjusted for unearned discount and deferred expenses) or market value. Mortgage loans held for sale with a designated hedge are reported at cost, with adjustments to cost for the change in fair value attributable to the hedged risk.

Purchase Accounting for Acquisition of Real Estate

The fair value of rental real estate acquired subject to existing leases is allocated to the following based on fair values:

·	the acquired tangible assets, consisting of land, building and improvements; and

·	identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, the value of in-place leases and the value of tenant relationships, based in each case on their fair values.

In estimating the fair value of the tangible and intangible assets acquired, the Company considers information obtained about each property as a result of its due diligence activities and other market data, and utilizes various valuation methods, such as estimated cash flow projections utilizing appropriate discount and capitalization rates, estimates of replacement costs, and available market information. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant.

Above-market and below-market lease values for acquired properties are recorded based on the present value (using a discount rate which reflects the risks associated with the leases acquired) of the differences between (i) the contractual amounts to be paid pursuant to each in-place lease and (ii) management’s estimate of fair market lease rates for each corresponding in-place lease, measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market rate renewal options for below-market leases. The capitalized above-market lease values are amortized as a reduction of base rental revenue over the remaining term of the respective leases, and the capitalized below-market lease values are amortized as an increase to base rental revenue over the remaining initial terms plus the terms of any below-market fixed rate renewal options of the respective leases.

Other intangible assets acquired include amounts for in-place lease values and tenant relationship values which are based on management's evaluation of the specific characteristics of each tenant's lease and the Company’s overall relationship with the respective tenant. Factors considered by management in its analysis of in-place lease values include an estimate of carrying costs during the hypothetical expected time it would take management to find a tenant to lease the space for the existing lease term (a “lease-up period”) considering current market conditions, and costs to execute similar leases. Management estimates carrying costs, including such factors as real estate taxes, insurance and other operating expenses during the expected lease-up period, considering current market conditions and costs to execute similar leases. In estimating costs to execute similar leases, management considers leasing commissions, legal and other related expenses. Characteristics considered by management in valuing tenant relationships include the nature and extent of the Company’s existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant's credit quality and expectations of lease renewals. The value of in-place leases is amortized to expense over the remaining initial terms of the respective leases. The value of tenant relationship intangibles is amortized to expense over the anticipated life of the relationships.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Depreciation is determined by the straight-line method over the remaining estimated economic useful lives of the properties. The Company generally depreciates buildings and building improvements over periods not exceeding 40 years. Direct costs incurred in acquiring properties are capitalized. Expenditures for maintenance and repairs are charged to operations as incurred. Significant renovations which extend the useful life of the properties are capitalized.

Securities Available for Sale

Securities are classified as available-for-sale securities and are reported at fair value on the Company’s balance sheet, with unrealized gains and losses included in other comprehensive income, and other than temporary impairments included in current earnings on the income statement, in accordance with the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Company has also adopted the disclosure requirements of EITF Issue No. 03-01 regarding disclosures to be made when held-to-maturity or available-for-sale investments are impaired at the balance sheet date but for which an “other than temporary” loss has not been recognized.

Structuring Fees Receivable

Structuring fees receivable are initially recorded at the discounted value of expected cash receipts, and periodically evaluated for impairment. In accordance with SAB 104, fee revenue is recognized as earned when the following criteria are met: (i) evidence of an arrangement exists; (ii) services have been rendered; (iii) the fee is fixed or determinable; and (iv) collectibility is reasonably assured. The Company amortizes the receivable balance as cash is collected, allocating a portion of the cash received to principal and interest.

Deferred Origination Costs

In accordance with SFAS No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, the Company defers the recognition of fees and expenses associated with the origination of its commercial mortgage loans held for investment. These items include lender fee income, rate lock income, certain legal fees, insurance costs, rating agency fees and certain other expenses. Deferred fees and costs are recognized as an adjustment to the effective yield over the life of the related asset.

Sale of Commercial Mortgage Loans

As part of the Company’s current business operations, the Company sells a limited number of mortgage loans. Prior to its initial public offering in March 2004, the Company sold a majority of its mortgage loans. The Company does not retain servicing rights for sold loans. In these instances, the Company will derecognize assets sold, record assets received or retained and record a gain or loss on sale. The asset received is generally cash. In certain sale transactions, the Company retains a small cash flow interest in the loans being sold. The Company accounted for sales of mortgage loans in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Derivative and Other Risk Management Transactions

The Company accounts for derivatives in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). The Company measures derivative instruments at fair value and records them as an asset or liability, depending on the Company’s rights or obligations under the applicable derivative contract. For derivatives designated as fair value hedges, the changes in the fair value of both the derivative instrument and the hedged item are recorded in earnings. For derivatives designated as cash flow hedges, the effective portions of the derivative are reported in other comprehensive income ("OCI") and are subsequently reclassified into earnings when the hedged item affects earnings. Changes in fair value of derivative instruments not designated as hedging and ineffective portions of hedges are recognized in earnings in the affected period.

Prior to the CLF, Inc.'s conversion to a REIT on March 24, 2004, the Company used derivatives consisting of U.S. Treasury and Agency lock transactions ("Locks") to hedge interest rate risk associated with owning fixed rate mortgage loan assets financed by floating rate debt. These Locks, to the extent that the Company has designated them and they qualify as part of a hedging relationship, are treated as fair value hedges in accordance with SFAS 133.

Subsequent to REIT conversion, the Company began using forward starting interest rate swaps to hedge the variable of changes in the interest-related cash outflows on forecasted future borrowings. These interest rate swaps, to the extent that the Company has designated them and they qualify as part of a hedging relationship, are treated as cash flow hedges in accordance with SFAS 133.

Revenue Recognition

Interest income from mortgage loans (including mortgage loans with associated valuation reserves), securities, and structuring fees receivable, are recognized on the accrual basis of accounting. Interest income from securities (including interest-only strips) is recognized over the life of the investment using the effective interest method. The cost basis of interest-only strips is adjusted to reflect any prepayments from underlying assets, using the initial yield-to-maturity at the purchase date.

Rental revenue on real estate is recognized in accordance with SFAS No. 13, Accounting for Leases. Rental revenue is recognized on a straight-line basis over the non-cancelable term of the lease unless another systematic and rational basis is more representative of the time pattern in which the use benefit is derived from the leased property.

Gains are recognized on the sale of mortgage loans and securities in accordance with the requirements of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. As part of the Company’s 10-year credit tenant loan program, it originates a loan and bifurcates the loan into two notes-a real estate note and a corporate credit note. The Company generally sells the real estate note to a third party and retains the corporate credit note in portfolio. The Company computes gain on these sales by comparing the sales proceeds on the note to its cost basis. The Company computes its cost basis on the note by allocating the entire basis in the loan between the two notes based on the present value of expected cash flows on each note. In computing present values, management estimates a discount rate based on a benchmark rate plus a market spread based on the underlying credit. These estimates reflect market rates that management believes are reasonable. However, the use of different estimates could have an impact on the calculation of gain on sale revenue.

Advisory fees receivable are recognized upon the completion of the advisory services when the amount is estimable and collection is probable. The value of the receivable is based on the present value of the expected cash flows and amortized as advisory fee payments are received.

The Company may periodically receive breakup fees on contracts in connection with its investments in real estate. The Company recognizes revenues from contract breakup fees when the contractual conditions have occurred to trigger the receipt of such a fee, when the amounts of such revenue can be reasonably determined, and when collection is probable.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Lease Enhancement Mechanisms

The Company utilizes the following lease enhancement mechanisms, primarily as part of its mortgage lending programs:

·	casualty and condemnation insurance policies that protect the Company from any right the tenant may have to terminate the underlying net lease or abate rent as a result of a casualty or condemnation;

·	with respect to a double net lease, borrower reserve funds that protect the Company from any rights the tenant may have to terminate the underlying net lease or abate rent as a result of the failure of the property owner to maintain and repair the property or related common areas; and

·	residual value insurance policies on net lease loans that have an amortization period that extends beyond the initial term of the underlying net lease that insure against the risk that the borrower defaults and the property is worth less than the balloon balance at maturity.

Costs incurred by the Company for lease enhancement mechanisms are typically charged to the borrowers. In instances where costs are not fully absorbed by the borrower, costs are treated in accordance with SFAS No. 91, as a cost of mortgage loan origination.

Provision for Credit Losses

The Company’s accounting policies require that an allowance for estimated credit losses be maintained at a level that management, based upon an evaluation of known and inherent risks in the portfolio, considers adequate to provide for credit losses on its mortgage loan and securities portfolio. Management provides a portfolio reserve based upon its periodic evaluation and analysis of the mortgage loans in portfolio, historical and industry loss experience, economic conditions and trends, collateral values and quality, and other relevant factors. Valuation allowances are established for loans in the amount by which the carrying value, before allowance for estimated losses, exceeds the fair value of collateral on a portfolio basis. Losses are recognized through a loss provision on the balance sheet with a corresponding charge to the provision for loss in the income statement. At December 31, 2004, there was no provision for credit losses.

Impairment of Long-Lived Assets

The Company reviews its investment in long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In August 2001, SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” was issued. SFAS No. 144 supersedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The adoption of SFAS No. 144 by the Company on January 1, 2002 did not have a material effect on its results of operations or financial position. There were no impairment reserves taken for the years ended December 31, 2004, 2003 and 2002.

Marketing and Advertising Costs

The Company expenses marketing and advertising costs as incurred. Marketing and advertising expense totaled $688, $544, and $414 in 2004, 2003, and 2002, respectively.

Income Taxes

CLF, Inc. is subject to federal income taxation at corporate rates on its "REIT taxable income"; however, CLF, Inc. is allowed a deduction for the amount of dividends paid to its stockholders, thereby subjecting the distributed net income of CLF, Inc. to taxation at the stockholder level only. CLF, Inc. intends to operate in a manner consistent with and to elect to be treated as a REIT for tax purposes. The Company conducts a portion of its business through a taxable REIT subsidiary (“TRS”), and the income from the activities at the TRS is subject to federal and state taxation at the applicable corporate rates.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Other Comprehensive Income

In accordance with SFAS No. 130, Reporting Comprehensive Income, the Company recognizes the change in fair value of its securities held for sale through other comprehensive income. In accordance with SFAS No. 133, the Company recognizes the change in fair value, and gains and losses from its cash flow hedges through other comprehensive income. Realized gains and losses from cash flow hedges related to the Company’s debt issuances are amortized as a component of interest expense over the term of the related financing, using the constant interest method.

Earnings per Share

In accordance with the Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"), the Company presents both basic and diluted earnings per share ("EPS"). Basic EPS excludes dilution and is computed by dividing net income allocable to common shareholders by the weighted average number of shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, where such exercise or conversion would result in a lower EPS amount.

For the year ended December 31, 2004, EPS and weighted average shares outstanding include the 254,186 non-vested shares issued under CLF, Inc.’s stock incentive plan. For the year ended December 31, 2004, EPS is computed based on the net income divided by the weighted average shares outstanding during the period of 22,124,934. For the years ended December 31, 2003 and 2002, EPS and shares outstanding are presented on a pro forma basis, which assumes that 4,107,934 shares were outstanding during these periods. This share number represents 3,968,800 shares of common stock issued to the owners of the Predecessor in exchange for their members’ capital, and 139,134 shares sold to certain current and former employees of the Predecessor in November 2003. Pro forma EPS information is computed based on the net income divided by 4,107,934. There were no potentially dilutive shares of common stock outstanding for the years ended December 31, 2004, 2003 and 2002.

Recently Issued Accounting Pronouncements

On December 16, 2004, the FASB issued SFAS No. 153: Exchanges of Non-monetary Assets − An Amendment of APB Opinion No. 29. The amendments made by SFAS No. 153 are based on the principle that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for non-monetary exchanges of similar productive assets and replace it with a broader exception for exchanges of non-monetary assets that do not have “commercial substance.” SFAS No. 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not believe the adoption of SFAS No. 153 on June 15, 2005 will have a material effect on the Company’s consolidated financial statements.

On December 16, 2004, the FASB issued SFAS No. 123: (Revised 2004) − Share-Based Payment (“SFAS No. 123R”). SFAS 123R replaces SFAS No. 123, which the Company adopted on January 1, 2003. SFAS No. 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements and be measured based on the fair value of the equity or liability instruments issued. SFAS No. 123R is effective as of the first interim or annual reporting period that begins after June 15, 2005. The Company does not believe that the adoption of SFAS No. 123R will have a material effect on the Company’s consolidated financial statements.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Reclassification

Certain prior year amounts have been reclassified to conform to the current presentation.

3.	Cash and Cash Equivalents

The Company defines cash equivalents as highly liquid investments purchased with maturities of three months or less at date of purchase. From time to time, the Company’s account balance held at financial institutions exceeds Federal Depository Insurance Corporation (“FDIC”) insurance coverage and, as a result, there is a concentration of credit risk related to the balance on deposit in excess of FDIC insurance coverage. The Company believes that the risk of loss is not significant.

4.	Mortgage Loans

Mortgage loans held for investment at December 31, 2004 and held for sale at December 31, 2003 consist predominantly of loans on properties subject to leases to investment grade companies with credit ratings generally ranging from AA to BB from Standard & Poor’s:

		December 31,
		2004			2003
Principal	$	206,735		$	72,370
Cost premium (unearned discount)		1,158			(740	)
Cost basis		207,893			71,630
Mark to fair value on mortgage loans being hedged		–			343
Carrying amount of mortgages		207,893			71,973
Deferred origination fees, net		(546	)		(216	)
Total	$	207,347		$	71,757

At December 31, 2004 and December 31, 2003, the mortgage loans carried interest rates ranging from 4.71% to 10.00% and 4.71% to 8.10%, respectively. At December 31, 2004 and December 31, 2003, the weighted average effective interest rate on the mortgage loans, as measured against our cost basis, was 6.56% and 6.36%, respectively.

During 2000, the Company recorded a valuation provision of $2,000 related to a group of mortgage loans with Rite Aid Corporation as the tenant under the related leases. During 2002, the provision was reduced by $83 due to the prepayment of a Rite Aid loan. During 2003, the provision was eliminated in connection with the sale of the remaining Rite aid loans held in portfolio. For the years ended December 31, 2003 and 2002 all scheduled principal and interest payments remained current under the term of the Rite Aid mortgage loans. Interest income earned on the Rite Aid loans for the years ended December 31, 2003 and 2002 was approximately $1,210 and $1,893, respectively. During 2003, the Company sold Rite Aid mortgage loans with an aggregate principal amount of $24,920, and recorded a gain-on-sale of $1,756.

5.	Real estate investments

During the year ended December 31, 2004, the Company acquired 9 real estate properties for an aggregate purchase price of approximately $188 million. There were no dispositions of real estate properties during 2004.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Real estate held for investment and related intangible liabilities on real estate investments consisted of the following at December 31, 2004:

		December 31,
		2004
Real estate investments, at cost:
Land and improvements	$	28,226
Building and improvements		154,374
Intangible assets under SFAS 141		13,222
Less: Accumulated depreciation		(1,281	)
Real estate investments, net	$	194,541
Intangible liabilities on real estate investments	$	7,028

Some leases provide for scheduled rent increases throughout the lease term. Such amounts are recognized on a straight-line basis over the terms of the leases. For the year ended December 31, 2004, the Company recognized $507 of such revenue. At December 31, 2004, the balance of accrued rental income was $507. Amortization of intangible assets on real estate investments totaled $295 for the year ended December 31, 2004 and is included in “Depreciation and amortization expense” on the Company’s Consolidated Income Statement. Amortization of intangible liabilities on real estate investments totaled $80 for the year ended December 31, 2004, and is included in “Rental revenue” on the Company’s Consolidated Income Statement.

Scheduled amortization on existing intangible assets and liabilities on real estate investments is as follows:

		Intangible Assets		Intangible Liabilities
2005	$	1,224	$	396
2006		1,224		396
2007		1,224		396
2008		1,224		396
2009		1,224		396
Thereafter		7,102		5,048
	$	13,222	$	7,028

The Company’s analysis of intangible assets and liabilities acquired in connection with the acquisition of real estate properties is preliminary.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

6.	Securities and Structuring Fees Receivable

Securities available for sale at December 31, 2004 and at December 31, 2003 consisted of the following:

	Scheduled		December 31,
Description	Maturity Date		2004			2003
Face amount-BSCMS 1999-CLF1, Class E (rated BB)	Nov 2023	$	3,326		$	3,326
Face amount-BSCMS 1999-CLF1, Class F (rated B-)	May 2028		2,494			2,494
Face amount-CALFS 1997-CTL1, Class D (rated BBB)	Nov 2018		3,000			–
Face amount-CMLBC 2001-CMLB-1 Class E (rated BBB+)	Nov 2022		9,526			–
Face amount-CMLBC 2001-CMLB-1 Class G (rated BBB-)	Jul 2023		9,526			–
Face amount-CMLBC 2001-CMLB-1, Class H (rated BB)	Jan 2024		11,907			11,907
Face amount-CMLBC 2001-CMLB-1, Class J (rated B)	Aug 2024		7,144			7,144
Face amount-CMLBC 2001-CMLB-1, Class K (not rated)	Oct 2025		4,766			4,766
Face amount-NLFC 1999 LTL1, Class D (rated BBB)	Nov 2022		5,000			5,000
Face amount-NLFC 1999 LTL1, Class E (rated BB-)	Apr 2022		11,081			–
Cost-NLFC 1999 LTL1, Class X/IO (rated AAA)	Jan 2024		9,908			–
Face amount-Yahoo, Inc. 6.65% Certificates (tenant rated BBB-)	Aug 2026		16,999			–
Face amount-CVS Pass Through Certificates (tenant rated A-)	Jan 2023		6,180			–
Face amount-BACMS 2002-2, Class V-1 (tenant is rated BBB)	Sep 2019		361			331
Face amount-BACMS 2002-2, Class V-2 (tenant is rated BBB-)	Jan 2021		553			508
Face amount-CREST 2001-1A, Class A (rated AAA)	Nov 2010		–			20,397
Unearned discount			(24,224	)		(17,907	)
Cost basis			77,547			37,966
Unrealized appreciation on securities held for sale			10,209			2,088
Total		$	87,756		$	40,054

Unrealized gains and losses on securities available for sale at December 31, 2004 and 2003 included as a component of other comprehensive income consisted of the following:

	December 31,
		2004		2003
Unrealized gains on securities available for sale		10,266		2,494
Unrealized losses on securities available for sale		(57	)	(406	)

At December 31, 2004 and December 31, 2003, the effective interest rate (yield to maturity on adjusted cost basis) on securities available for sale was 9.9% and 7.5%, respectively. The investment in CREST 2001-1A bonds was made during December 2003, and was subsequently sold during January 2004 at cost. There were no sales of securities during 2003 or 2002. During the year ended December 31, 2004, the Company sold $35.5 million of corporate securities at cost that were held as temporary investments.

Structuring fees receivable of $4,426 and $5,223 at December 31, 2004 and December 31, 2003, respectively, were earned by the Company in conjunction with the structuring and subsequent sale of certain net lease loans. Such fees are payable to the Company monthly without interest through March 2020 and, accordingly, have been discounted based on imputed interest rates estimated by management to approximate market. Structuring fees receivable are shown at their amortized cost.

At December 31, 2004, the Company wrote-down its investment in BSCMS 1999-CLF1 Class F bonds to reflect an other-than-temporary impairment on this security, as the result of the bankruptcy of Winn-Dixie during February 2005. Winn-Dixie is the tenant on two mortgage loans in the underlying CMBS transaction. One of the two stores and related mortgage loan was the subject of a lease rejection by Winn-Dixie as part of its initial bankruptcy filing in February 2005. Management estimated the likely impact of the lease rejection on the value of the Class F security, and as a result, recognized a loss of $247, which is included in “Loss on securities” in the Company’s Consolidated Income Statement.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

7.	Fair Value of Financial Instruments

For certain of the Company’s financial instruments, fair values are not readily available since there are no active trading markets as characterized by current exchanges between willing parties. Accordingly, the Company derives or estimates fair values using various valuation techniques, such as computing the present value of estimated future cash flows using discount rates commensurate with the risks involved. However, the determination of estimated cash flows may be subjective and imprecise. Changes in assumptions or estimation methodologies can have a material effect on these estimated fair values. In that regard, the derived fair value estimates may not be substantiated by comparison to independent markets, and in many cases, may not be realized in immediate settlement of the instrument. The fair values indicated below are indicative of the interest rate and credit spread environment as of December 31, 2004, and may not take into consideration the effects of subsequent interest rate, credit spread fluctuations, or changes in the ratings of the tenant obligors under related credit tenant leases.

The fair values of cash and cash equivalents, prepaid expenses and other assets (which includes prepaid expenses, accrued interest receivable, and other assets), accounts payable and accrued expenses, deposit and escrows, due to servicer and dealers, and dividend payable approximate their carrying values due to the short maturities of these items.

The carrying amounts and estimated fair values of the Company’s other financial instruments at December 31, 2004 are as follows:

		Carrying Amount		Notional Amount		Estimated Fair Value
Assets:
Mortgage loans held for investment	$	207,893	$	206,735	$	215,330
Securities available for sale-CMBS		87,756		101,771		87,756
Structuring fees receivable		4,426		N/A		4,426
Derivative assets		42		4,868		42
Liabilities:
Repurchase agreements		133,831		133,831		133,831
Mortgages on real estate investments		111,539		110,732		110,574
Derivative liabilities		7,355		228,182		7,355

The methodologies used and key assumptions made to estimate fair values are as follows:

Mortgage loans held for investment—The fair value of our fixed-rate loan portfolio is estimated with a discounted cash flow analysis, utilizing scheduled cash flows and discount rates estimated by management to approximate those that a willing buyer and seller might use.

Securities available for sale—The fair value of securities available for sale is estimated by obtaining broker quotations, where available, based upon reasonable market order indications or a good faith estimate thereof. For securities where market quotes are not readily obtainable, management may also estimate values, and considers factors including the credit characteristics and term of the underlying security, market yields on securities with similar credit ratings, and sales of similar securities, where available.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Structuring fees receivable—The fair value of structuring fees receivable is estimated with a discounted cash flow analysis, utilized scheduled cash flows and discount rates estimated by management to approximate those that a willing buyer and seller might use.

Repurchase agreements—Management believes that the stated interest rates (all of which are floating rate, based on short-term interest rates) approximate market rates (when compared to similar credit facilities with similar credit risk). As such, the fair value of the repurchase agreements is estimated to equal the carrying amounts (outstanding principal amounts) of the repurchase agreements.

Mortgages on real estate investments—The fair value of mortgages payable on real estate investments is estimated using a discounted cash flow analysis, based on management’s estimates of market interest rates. For mortgages where the Company has an early prepayment right, management also considers the prepayment amount to evaluate the fair value.

Derivative obligations and short sales of securities—The fair value of the Company’s derivative obligations and short sales of securities is estimated using current market quotes and third-party quotations, where available.

8.	Repurchase Agreements

As of December 31, 2004, the Company had repurchase agreements in place for short-term liquidity requirements with Wachovia Bank, N.A. and Bank of America, N.A.

Wachovia Bank, N.A.

During September 2004, the Company entered into a new master repurchase agreement with Wachovia Bank, N.A. to finance its asset investments on a short-term basis prior to obtaining long-term financing. The master repurchase agreement replaced the Company’s existing credit facilities with Wachovia Bank. Under the agreement, Caplease, LP and certain of the Company’s other subsidiaries will sell assets to Wachovia Bank and agree to repurchase those assets on a date certain at a repurchase price generally equal to the original purchase price plus accrued but unpaid interest. Wachovia Bank will purchase each asset financed under the facility at a percentage of the asset’s value on the date of origination (the purchase rate) and the Company will pay interest to Wachovia Bank at prevailing short-term interest rates (one-month LIBOR) plus a pricing spread. The Company has agreed to a schedule of purchase rates and pricing spreads with Wachovia Bank generally based upon the class and credit rating of the asset financed. The facility is recourse to the Company and CLF, Inc. has agreed to guarantee all obligations of its subsidiaries under the agreement. For financial reporting purposes, the Company characterizes all of the borrowings under the facility as on balance sheet financing transactions.

The repurchase agreement is a $250 million uncommitted facility, meaning Wachovia Bank must agree to each asset financed under the agreement. The facility may be increased to $450 million if requested by the Company and Wachovia Bank agrees.

The agreement expires on September 21, 2005, but may be extended for not more than two successive 364 day periods if requested by the Company and Wachovia agrees. The Company expects that it will request to renew the facility at its 2005 expiration date.

The Company can finance each of its existing primary products under the agreement, including commercial real estate whole loans, commercial mortgage backed securities (“CMBS”) and acquisitions of commercial real estate. Commercial real estate acquisitions will be financed through mortgage loans made by Caplease, LP to a subsidiary of Caplease, LP formed for the purpose of owning the real property acquired followed by the sale of such mortgage loans to Wachovia under the terms of the facility. Unless otherwise agreed to by Wachovia, for any asset financed under the facility for more than 240 days Wachovia may (a) require that the asset be removed from the facility or (b) require all income generated by the asset be applied to reducing the outstanding balance under the facility.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

The agreement includes sublimits on certain asset classes and credit or tenant concentrations.

If at any time (i) the repurchase price of any financed asset exceeds its asset value (as defined in the agreement), (ii) either Standard & Poor’s or Moody’s downgrades any asset financed under the facility or (iii) the aggregate repurchase price of all financed assets exceeds the maximum facility size, Wachovia Bank may require a repurchase of the assets or a contribution of additional cash or other eligible assets to satisfy the difference.

The Company is required to maintain the following financial covenants during the term of the agreement:

·	liquidity (as defined in the agreement) of at least $8 million; and

·	consolidated tangible net worth (as defined in the agreement) of at least $100 million (plus 75% of the aggregate net proceeds from future equity offerings or capital contributions).

Wachovia Investors, Inc., an affiliate of Wachovia Bank, owns approximately 3.7% of CLF, Inc.’s outstanding common stock. From time to time, the Company may sell net lease assets to, or finance net lease assets on a long-term basis with, Wachovia Bank or its affiliates on what management believes are fair market terms. In addition, Wachovia Bank acts as servicer of the Company’s net lease loan assets and the transfer agent of CLF, Inc.’s common stock.

Bank of America, N.A.

Under the terms of the Bank of America credit facility, the Company sells commercial mortgage loans to Bank of America in exchange for funds to finance net lease properties. Simultaneously with the sale of the loan, Bank of America sells the Company a call option granting the Company the right to repurchase the commercial mortgage loans from Bank of America. In addition, the Company has the option to purchase Bank of America originated commercial mortgage loans and contribute those loans to the credit facility. The interest rate on commercial mortgage loans subject to the call option is set at one-month LIBOR plus 1.50%.

As part of this facility, Bank of America also may agree to finance the Company’s CMBS investments. Each such CMBS financing matures after 30 days, but may be renewed by Bank of America. Upon maturity of the financing, all related borrowings and interest thereon must be repaid. The interest rate on CMBS borrowings is based on the credit rating of the underlying bonds.

As of December 31, 2004, the Company had no amounts outstanding under its Bank of America credit facility. On March 1, 2005, the facility expired unused.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Amounts related to the Company’s credit facilities are as follows:

		December 31, 2004						December 31, 2003
		BofA (a)		Wachovia		Total		BofA		Wachovia		Total
Collateral face
Mortgage loans	$	22,800	$	136,477	$	159,277	$	29,562	$	42,808	$	72,370
CMBS		–		41,130		41,130		5,000		26,217		31,217
Total	$	22,800	$	177,607	$	200,407	$	34,562	$	69,025	$	103,587

Financing
Mortgage loans	$	–	$	102,288	$	102,288	$	26,702	$	34,734	$	61,436
CMBS		–		31,543		31,543		2,063		24,588		26,651
Total	$	–	$	133,831	$	133,831	$	28,765	$	59,322	$	88,087

(a) Collateral is pledged against interest rate swap positions with a national amount of $73,025 at December 31, 2004

Weighted average interest rates on the Company’s credit facilities for the twelve months ended December 31, 2004 and 2003 are as follows:

	December 31,
	2004		2003
Bank of America-mortgage loan repurchase agreements	2.59	%	2.76	%
Bank of America-CMBS repurchase agreements	1.90	%	2.01	%
Wachovia-mortgage loan repurchase agreements	2.64	%	2.24	%
Wachovia-CMBS repurchase agreements	2.48	%	3.21	%

As of December 31, 2004 and 2003, the 1-month LIBOR rate was 2.40% and 1.12%, respectively. As of December 31, 2004, the Company was in compliance with the terms of the repurchase agreements with its warehouse lenders.

The Company’s credit facilities generally carry maturities of less than one year. The Company does not anticipate any issues with renewing its existing credit facility with Wachovia when it matures in September 2005. Regardless, however, the Company has a strong history of negotiating credit facilities with lenders, and management is confident that it can find replacement credit facilities if the need arises.

9.	Risk Management Transactions

SFAS 133, as amended and interpreted, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. As required by SFAS 133, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. A third category of derivatives, hedges of net investments in foreign operations, is not used by the Company. The Company does not use derivatives for trading or speculative purposes and does not currently have any derivatives that are not designated as hedges.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction. Any hedge ineffectiveness is recognized in the current period in loss on derivatives and short sales on the statement of operations.

The Company’s objectives in using derivatives include adding stability to interest expense and managing its exposure to interest rate movements. For the years ended December 31, 2004 and 2003, the Company has used risk management transactions consisting of U.S. Treasury and Agency lock transactions (“Locks”), and interest rate swaps.

Prior to CLF, Inc.’s conversion to a REIT on March 24, 2004, the Company used Locks to hedge the interest rate risk associated with owning fixed rate mortgage loan assets financed by floating rate debt. Subsequent to REIT conversion, the Company began using forward starting interest rate swaps to hedge the variability of changes in the interest-related cash outflows on forecasted future borrowings. As of December 31, 2004, the Company was hedging its exposure to such variability through February 2015. In accordance with SFAS 133, the Locks and interest rate swaps, to the extent that they have been designated and qualify as part of a hedging relationship, are treated as fair value hedges and cash flow hedges, respectively, for accounting purposes.

Interest rate swaps are agreements between two parties to exchange, at particular intervals, payment streams calculated on a specified notional amount. The interest rate swaps that the Company has entered into are single currency interest rate swaps and, as such, do not require the exchange of a notional amount.

Amounts related to open positions are as follows:

		December 31, 2004					December 31, 2003
Description		Notional Amount		Fair value			Notional Amount		Fair value
Interest rate swaps	$	228,182	$	(7,312	)		–		–
U.S. Treasury lock agreements		–		–			10,700		189
U.S. Agency lock agreements		–		–			28,700		(673	)
Total	$	228,182	$	(7,312	)	$	39,400	$	(484	)

At December 31, 2004 and December 31, 2003, the Company had hedged the following assets, firm commitments under rate lock agreements, and future borrowings:

		December 31,
		2004		2003
Mortgage loans held for sale (principal amount)	$	–	$	25,196
Securities held for sale (principal amount)		–		331
Future borrowings (principal amount)		228,182		–
Total	$	228,182	$	25,527

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

At December 31, 2004 and 2003, respectively, derivatives with a fair value of $7,355 and $484 were included in derivative liabilities on the Company’s balance sheet. At December 31, 2004, derivatives with a fair value of $42 were included in derivative assets on the Company’s balance sheet. The change in net unrealized losses of $7,312 in 2004 for derivatives designated as cash flow hedges is separately disclosed in the statement of changes in stockholders’ equity / members’ capital.

The net loss recognized in the loss on derivatives and short sales of securities in the statement of operations for the year ended December 31, 2004 and December 31, 2003 related to hedge ineffectiveness was $0 and $4, respectively. During 2004, the Company paid $2,375 to terminate an interest rate swap that was hedging a future issuance of debt, which occurred after the termination of the swap. This amount had been deferred in accumulated other comprehensive loss and will be reclassified into interest expense as the hedged interest payments occur. The Company reclassified $24 from accumulated other comprehensive loss into interest expense in 2004 as hedged forecasted interest payments related to the debt issuance actually occurred. During 2005, the Company estimates that an additional $1,057 will be reclassified as additional interest expense.

10.

Mortgages Notes on Real Estate Investments

Mortgage notes payable collateralized by the respective properties (aggregating $153,690) and assignment of leases at December 31, 2004 are as follows:

Property Level Debt - Fixed Rate		2004	Interest Rate		Maturity
Choice, Silver Spring, MD	$	32,625	5.30	%	May-13
AON Corporation, Glenview, IL		64,800	5.23	%	Nov-14
GSA, Ponce, PR (a)		8,117	6.47	%	Apr-16
Walgreen Co., Pennsauken, NJ (b)		2,347	6.06	%	Oct-16
Walgreen Co., Portsmouth, VA (c)		3,650	6.19	%	Jul-18
Total	$	111,539

(a) Face amount of the debt outstanding at December 31 is $7,701, at a coupon of 7.30%. The carrying amount on the financial statements reflects a prepayment premium of $382 which was received from the seller at the time of purchase. The interest rate shown in the above table reflects the effective interest rate to the Company, as adjusted for the impact of the prepayment premium.

(b) Face amount of the debt outstanding at December 31 is $2,162, at a coupon of 7.65%. The carrying amount on the financial statements reflects a premium based on the fair value of the debt assumed at the purchase date. The interest rate shown in the above table reflects the effective interest rate to the Company, as adjusted for the impact of the fair value adjustment.

(c) Face amount of the debt outstanding at December 31 is $3,410, at a coupon of 7.20%. The carrying amount on the financial statements reflects a premium based on the fair value of the debt assumed at the purchase date. The interest rate shown in the above table reflects the effective interest rate to the Company, as adjusted for the impact of the fair value adjustment.

Scheduled principal amortization and balloon payments for mortgage notes payable for the next five years and thereafter are as follows:

		Scheduled Amortization		Balloon Payments		Total
2005	$	1,159	$	–	$	1,159
2006		1,323		–		1,323
2007		1,636		–		1,636
2008		2,832		–		2,832
2009		3,223		–		3,223
Thereafter		21,692		79,674		101,366
	$	31,865	$	79,674	$	111,539

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

11.

Related Party Transactions

Approximately $81 was due from loans to employees as of December 31, 2004.

Approximately $41 was due from an affiliate of Hyperion Partners II L.P. (“HP”) as of December 31, 2003. This amount was received in full during the year ended December 31, 2004.

In 2000, the Predecessor entered into a guarantee arrangement with HP, whereby HP agreed to guarantee the Predecessor’s repurchase obligations with respect to twelve mortgage loans with Rite Aid Corporation, with an aggregate balance of approximately $34,700 and a carrying value of $33,800. As part of the financial guarantee from HP, the Predecessor agreed to reimburse HP for certain of its costs incurred as a result of the financial guarantee. During 2002, the Company recorded a guarantee fee of $130 due to HP for the financial guarantee. The guarantee fee was paid to HP during 2003, and HP was released from its guarantee during 2003.

During 2001, certain executive officers of the Company purchased an equity interest in a net lease property from a predecessor of the Company. No gain or loss was recorded on the transaction. As of December 31, 2002, the Company held a mortgage loan on that property, which carried a 6.95% interest rate. During 2003, the Company sold the mortgage loan into a Wachovia securitization and realized a gain of $64.

In February 2001, the Company originated a net lease loan on a property owned by a limited partnership in which certain executive officers of the Company have an indirect ownership interest. The loan was sold to Wachovia in February 2001, and the limited partnership agreed to pay the Company an advisory fee from the rent payable by the tenant in the amount of approximately $66 a month until November 2010. The Company recognized a gain on the sale of the mortgage loan of $4,963. An affiliate of the limited partnership is also a party to a management agreement with the tenant for the operation of the property, and another affiliate of the limited partnership subleases a portion of the leased building from the tenant at a nominal amount. No failure to perform under the management agreement or sublease entitles the tenant to any rent abatement or termination under the lease. Interest income earned on the structuring fee receivable totaled approximately $312, $350, and $383, during the years ended December 31, 2004, 2003, and 2002, respectively, and is included in interest income in the accompanying income statements.

On November 1, 2004, Caplease, LP entered into two contracts of sale with HP. Under the terms of the two contracts, the Company acquired HP’s beneficial interest in two trusts. Each trust’s sole asset is a free-standing Walgreen’s retail store, one located in Portsmouth, Virginia and the second located in Pennsauken, New Jersey. Caplease, LP paid HP an aggregate purchase price of approximately $7.2 million under the contracts, inclusive of the face amount of debt assumed of approximately $5.6 million. As required by the Company’s conflict of interest policy, this transaction was approved by the Company’s disinterested directors. The Company recorded the mortgage loans assumed in this purchase transaction at their respective fair values, totaling approximately $6.0 million.

For the years ended December 31, 2003 and 2002, the Company classified Wachovia Bank as a related party, because of its affiliate’s approximately 26.7% ownership in the Predecessor. Subsequent to the Company’s initial public offering, this ownership was reduced to approximately 3.7%, and as such, the Company no longer classifies Wachovia Bank as a related party. The Company has entered into a servicing arrangement with Wachovia Bank. Servicing fees paid to Wachovia Bank during the years ended December 31, 2004, 2003, and 2002 were $32, $41, and $33, respectively. From time to time, the Company sells mortgage loans to affiliates of Wachovia Bank. Loans with aggregate face amounts of approximately $0, $59,000 and $44,000 were sold to affiliates of Wachovia Bank during the years ended December 31, 2004, 2003 and 2002, respectively. The Company borrows from Wachovia Bank for mortgage loans on its real estate investments. Mortgage loans with aggregate face amounts of approximately $97,425 were consummated with Wachovia Bank during the year ended December 31, 2004. The Company has also entered into a repurchase agreement with Wachovia (see Note 8 above). During September 2004, the Company entered into an agreement for an affiliate of Wachovia Bank to act as placement agent on a secured debt issuance of approximately $268,500.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

12.

Commitments and Contingencies

As of December 31, 2004, the Company was obligated under non-cancelable operating lease agreements for office space and copy machines. The future minimum lease payments under these lease agreements at December 31, 2004 were:

2005	$	569
2006		241
	$	810

Included in general and administrative expense is rent expense of approximately $510, $510, and $438, (net of sublease income of $60, $60, and $60) for the years ended December 31, 2004, 2003 and 2002, respectively.

The Company is involved from time to time in litigation arising in the ordinary course of business. The Company is not involved in any matter, which Management believes will have a material adverse effect on its business, results of operations or financial conditions. During the year ended December 31, 2004, the Company settled a routine litigation matter for $20, which was recorded in the Company's Consolidated Income Statement under "General and administrative expenses.”

The Company is obligated under a letter of credit with respect to one of its 1999 securitization transactions (BSCMS 1999-CLF1). The maximum potential amount of future required payments under the letter of credit is $2,850. The letter of credit expires on February 18, 2009. The trustee may draw the letter of credit if there are realized losses on the mortgage loans that would create a shortfall in the interest or principal on any investment grade certificate. The letter of credit may be withdrawn when the ratings of the investment grade certificates are no longer dependent upon the credit support provided by the letter of credit. As of December 31, 2004, there have been no defaults and no losses on any of the mortgage loans in the collateral pool. During February 2005, one of the mortgage loans on a property net leased to Winn-Dixie defaulted, as a result of the bankruptcy of Winn-Dixie. However, management does not expect any draw on the letter of credit as a result of this mortgage default, or otherwise. Letter of credit fees included in interest expense were $100, $117, and $64 in 2004, 2003 and 2002, respectively.

The Company has outstanding commitments to fund mortgage loans of approximately $1,979 related to certain of its development or joint-venture loans as of December 31, 2004. As of December 31, 2004, advances of $837 had been made against these commitments.

13.

Stock Based Compensation

The Company adopted an incentive stock compensation plan for its employees during March 2004 in connection with its initial public offering. The shares issued under the stock plan are accounted for under Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock Based Compensation." The Company accounts for stock based compensation using the intrinsic value method proscribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB25”) and related interpretations. APB25 requires compensation cost to be measured as the fair value of the Company’s stock less the amount, if any, that the employee is required to pay. During the year ended December 31, 2004, CLF, Inc. granted 383,766 shares of common stock to employees and directors, simultaneous with the completion of its public equity offering. Of this total, 129,580 shares were immediately vested on the date of grant. During the year, 3,630 shares were granted to a new employee, and 3,630 shares were forfeited as a result of an employee termination. The balance of the remaining shares from the stock grants at CLF, Inc.’s initial public offering (250,556 shares) vest over the two-year period ending March 24, 2006. The shares granted subsequent to the public offering date (3,630) vest over a three-year period from the date of initial grant. For accounting purposes, the Company measures compensation costs for these shares as of the date of the grant and expenses such amounts against earnings, either at the grant date (if no vesting period exists) or ratably over the respective vesting period. For the year ended December 31, 2004, compensation expense of $2,378 was recorded in the Company's Consolidated Income Statement under "General and administrative—stock based compensation expense."

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

On November 17, 2003, CLF, Inc. sold 139,134 shares to certain current and former employees of the Predecessor for $0.10 per share. The Company recorded no compensation expense in connection with the issuance of the 139,134 shares, since the fair value of the stock on the date of sale was equal to the $0.10 per share purchase price. Upon completion of CLF, Inc.’s initial public offering on March 24, 2004, the difference between the public offering price per share of $10.50 and the price at which these individuals purchased the shares was recognized as a $1,447 expense (a component of General and administrative—stock based compensation expense) in the Company's Consolidated Income Statement.

14.

Rental Income

CLF, Inc., through its wholly-owned subsidiaries, is the lessor to tenants under operating leases with expiration dates ranging from 2010 to 2019. The minimum rental amounts due under the leases are generally subject to scheduled fixed increases. The leases generally also require that the tenants pay for or reimburse us for the occupancy and operating costs of the properties, or in certain cases reimburse us for increases in certain operating costs and real estate taxes above their base year costs. Approximate future minimum rents to be received over the next five years and thereafter for non-cancelable operating leases in effect at December 31, 2004 for the properties are as follows (in thousands):

2005	$	15,467
2006		15,743
2007		16,042
2008		16,237
2009		15,771
Thereafter		101,026
	$	180,286

15.

Pro Forma Condensed Consolidated Income Statements (Unaudited)

The accompanying unaudited Pro Forma Condensed Consolidated Income Statements are presented as if, at January 1, 2003, the Company acquired all of the properties acquired during 2004. Earnings per share are presented using the pro forma shares outstanding during 2003, and the weighted average shares outstanding during 2004. In management's opinion, all adjustments necessary to reflect the effects of the above transactions have been made.

The unaudited Pro Forma Condensed Consolidated Income Statements are not necessarily indicative of what the actual results of operations would have been assuming the acquisition transactions had occurred at the dates indicated above, nor do they purport to represent our future results of operations.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

		2004		2003
Total revenues	$	37,350	$	41,148
Net income	$	4,301	$	11,420
Net income per diluted common share	$	0.19	$	2.78

16.

Concentration Risks

The Company relies on its repurchase agreements with its lenders (including Wachovia and Bank of America) to provide the majority of its cash for funding of investments. Deterioration in the financial condition of these financial institutions could have a negative impact on the Company’s ability to continue funding loans. However, management is confident that alternative funding sources could be obtained with substantially similar terms. As of December 31, 2004, Wachovia carried an A rating and Bank of America carried an A+ rating, each from Standard & Poor’s.

Approximately 20% of revenue was derived from one tenant during 2004-Aon Corporation.

17.

401K Plan

The Company has a 401(k) Savings/Retirement Plan (the “401(k) Plan”) in place to cover eligible employees of the Company. The 401(k) Plan permits eligible employees of the Company to defer a portion of their annual compensation, subject to certain limitations imposed by the Internal Revenue Service Code. The employee’s elective deferrals are immediately vested and non-forfeitable upon contribution to the 401(k) Plan. For the years ended December 31, 2004, 2003, and 2002, the Company made matching contributions of $241, $272, and $266, respectively.

18.

Segment Reporting

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes the manner in which public businesses report information about operating segments in annual and interim financial reports issued to stockholders. SFAS No. 131 defines a segment as a component of an enterprise about which separate financial information is available and that is evaluated regularly to allocate resources and assess performance. The Company conducts its business through two segments: net lease mortgage debt and operating net lease real estate. For segment reporting purposes, we do not allocate interest income on short-term investments or general and administrative expenses.

Selected results of operations for the year ended December 31, 2004 are as follows:

		Corporate / Unallocated			Operating Net Lease Real Estate		Lending Investments
Total revenues	$	603		$	6,356	$	14,045
Total expenses		11,869			4,206		3,569
Net income		(11,266	)		2,150		10,476
Total assets		31,454			247,325		302,923

19.

Other Comprehensive Income

The components of other comprehensive income for the years ended December 31, 2004, 2003 and 2002 are as follows (also see Notes 6 and 9):

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

		2004			2003			2002
Net income	$	1,360		$	6,633		$	832
Unrealized change in value on securities available for sale		8,121			(363	)		2,451
Unrealized loss on derivatives		(7,312	)		–			–
Realized loss on cash flow hedges		(1,694	)		–			–
Other comprehensive income	$	475		$	6,270		$	3,283

20.

Quarterly Financial Information (Unaudited)

The following table sets forth the selected quarterly financial data for the Company (in thousands, except per share amounts).

		Revenue		Net income applicable to common shares			Basic and diluted income per common share
2004
December 31	$	11,223	$	3,101		$	0.11
September 30		5,017		2,007			0.07
June 30		2,799		443			0.02
March 31		1,966		(4,192	)		(0.71	)
2003
December 31		4,535		1,689			0.41
September 30		4,607		3,678			0.90
June 30		6,426		1,173			0.29
March 31		3,553		93			0.02

The totals for the year may differ from the sum of the quarters as a result of weighting and rounding. Basic and diluted income per share are shown on a pro forma basis for 2003.

21.

Variable Interest Entities

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation Number 46, “Consolidation of Variable Interest Entities.” FIN 46 was revised by FIN 46(R) in December 2003 (as revised, “FIN 46”). FIN 46 defines a variable interest entity (“VIE”) as an entity with one or more of the following characteristics:

·	the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties;

·	equity holders either (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur; or

·	equity holders have voting rights that are not proportionate to their economic interests, and the activities of the entity involve or are conducted on behalf of an investor with a disproportionately small voting interest.

If an entity is deemed to be a VIE, an enterprise that absorbs a majority of the expected losses of the entity is considered the primary beneficiary and must consolidate the VIE.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

Based on the provisions of FIN 46, we have concluded that whenever we agree to purchase a real estate property by agreeing to acquire the entity that owns the property and pay the seller a deposit, a VIE is created if our deposit puts us, rather than the equity owners, in a first loss position. For each VIE created with a deposit, we will compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46. If we are deemed to be the primary beneficiary of the VIE we will consolidate it on our balance sheet.

Management believes FIN 46 was not clearly thought out for application in the real estate industry for agreements to acquire a real property and the payment of a deposit. Under FIN 46, we can agree to purchase a property subject to various conditions and put down a small deposit as a percentage of the purchase price and still have to consolidate the entity. We typically have the right to a refund of our deposit under certain circumstances, including if we determine not to proceed with the transaction for any reason during our due diligence review period. Therefore, our exposure to loss as a result of our involvement with the VIE may only be the deposit, not its total assets consolidated on the balance sheet. In addition, if the VIE has creditors, its debt will be placed on our balance sheet even though the creditors have no recourse against our Company. Based on these observations we believe consolidating VIEs based on an agreement to acquire real property and payment of a purchase price deposit does not reflect the economic realities or risks of the transaction.

On December 23, 2004, we entered into a purchase and sale agreement to acquire an office and technology center in Hanover Township, New Jersey for $48 million. We paid the seller a deposit of $2.0 million. The acquisition subsequently closed on January 6, 2005. We were required under FIN 46 to consolidate this acquisition at December 31, 2004. Our deposit represents our maximum exposure to loss. The fair value of the property, representing the purchase price we agreed to pay, was reported on our balance sheet as “Real estate investments consolidated under FIN 46.” Liabilities of the entity owning the property, which were retired in full at closing, were $4.8 million at December 31, 2004, and were reported on our balance sheet as “Mortgage on real estate investments consolidated under FIN 46.” The net balance of the assets and liabilities consolidated under FIN 46 for this VIE is reported on our balance sheet as “Minority interest in real estate investments consolidated under FIN 46.” Creditors of the VIE have no recourse against our Company.

As part of our developer loan program, we fund loans to an entity that owns an undeveloped property. These loans are used to finance pre-construction costs related to the property, such as due diligence costs and land acquisition contract deposits, rather than costs to build on the property. We have funded five such loans as of December 31, 2004, with an aggregate unpaid principal amount of approximately $0.8 million as of that date. We have determined that our borrowers are VIEs under FIN 46. However, because part of our collateral for these loans is a personal guarantee from each entity’s equity owner, we are not considered the primary beneficiary of these entities and, therefore, we are not required to consolidate them under FIN 46.

During 2004, we also funded a long-term credit tenant loan to an entity owning a property leased to Home Depot USA, Inc. in Westminster, Colorado. Our carry value on this loan was approximately $8.6 million as of December 31, 2004. In connection with funding the loan, we acquired the right to participate in any gain upon sale of the underlying property. The borrower entity similarly meets the criteria for a VIE under FIN 46, because the equity owners of the entity are required to share 25% of their expected residual returns with us. However, because we are not the primary beneficiary, we are not required to consolidate it.

22.

Subsequent Events

During January 2005, CLF, Inc. paid a dividend of $0.15 per common share outstanding, or approximately $4.1 million in aggregate, to its stockholders of record as of December 31, 2004.

Capital Lease Funding, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Dollar amounts in thousands)

December 31, 2004, 2003 and 2002

During January 2005, the Company acquired a commercial property located in Whippany, NJ for $48 million in cash. The Company had previously consolidated the assets, liabilities, revenues and expenses of the property in 2004 under FIN46. During February 2005, the Company obtained a $36.0 million mortgage financing on the property, at an effective interest rate of 5.26%. The loan matures in March 2015. The proceeds from this financing will be used by the Company to fund future asset investments.

The Company’s repurchase agreement with Bank of America expired during March 2005. The Company chose not to renew the existing facility. All obligations related to the repurchase agreement were satisfied.

During March 2005, the Company completed a long-term secured debt financing on a portfolio certain of its real estate, securities and mortgage loan investments. In connection with this financing, the Company issued $252 million of 4.926 % notes, and $16.5 million of 5.036% notes. The stated maturity of the notes is in January 2040, but the notes are expected to mature in January 2015. Inclusive of debt issuance and hedge costs, the effective blended financing rate on the notes was approximately 5.63%.

During March 2005, the Company declared a dividend of $0.18 per common share outstanding, or approximately $5.0 million in aggregate, payable on April 15, 2005 to its stockholders of record as of March 31, 2005.

Capital Lease Funding, Inc. and Subsidiaries

Real Estate and Accumulated Depreciation

December 31, 2004

(amounts in thousands)

Schedule III

Column A	Column B		Column C				Column D				Column E						Column F		Column G	Column H		Column I
			Initial Cost				Cost Capitalized Subsequent to Acquisition				Gross Amount at Which Carried at Close of Period
Description	Encumbrances		Land		Building and Improvements		Land		Building and Improvements		Land		Building and Improvements		Total		Accumulated Depreciation		Date of Construction	Date Acquired		Life on Which Depreciation is Computed
Abbott Labs, Columbus, OH	$	–	$	1,025	$	11,040	$	–	$	–	$	1,025	$	11,040	$	12,065	$	52			11/5/2004		40 yrs
AON Corporation, Glenview, IL		64,800		11,000		75,774		–		–		11,000		75,774		86,774		840			8/19/2004		40 yrs
Baxter International Inc., Bloomington, IN		–		1,200		9,579		–		–		1,200		9,579		10,779		57			10/13/2004		40 yrs
Bobs Store, Randolph, MA		–		6,300		7,801		–		–		6,300		7,801		14,101		50			9/29/2004		40 yrs
Choice Hotels International, Silver Spring, MD		32,625		5,500		40,113		–		–		5,500		40,113		45,613		138			11/23/2004		40 yrs
Crozer-Keystone Health System, Ridley, PA		–		–		5,015		–		174		–		5,188		5,188		50			8/9/2004		40 yrs
General Services Administration, Ponce, Puerto Rico		8,117		2,120		11,563		–		–		2,120		11,563		13,683		64			11/1/2004		40 yrs
Walgreen, Pennsauken, NJ		2,347		463		2,789		–		–		463		2,789		3,252		13			11/1/2004		40 yrs
Walgreen, Portsmouth, VA		3,650		618		3,750		–		–		618		3,750		4,367		17			11/1/2004		40 yrs
	$	111,539	$	28,226	$	167,424	$	–	$	174	$	28,226	$	167,597	$	195,822	$	1,281

Maryland (State or Other Jurisdiction of Incorporation or Organization)	52-2414533 (I.R.S. Employer Identification No.)
110 Maiden Lane, New York, NY (Address of Principal Executive Offices)	10005 (Zip code)

PART I.		1
Item 1.	Business.	1
Item 2.	Properties.	22
Item 3.	Legal Proceedings.	22
Item 4.	Submission of Matters to a Vote of Security Holders.	22
PART II.		23
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	23
Item 6.	Selected Financial Data.	25
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	27
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk.	38
Item 8.	Financial Statements and Supplementary Data.	57
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.	89
Item 9A.	Controls and Procedures.	89
Item 9B.	Other Information.	89
PART III.		90
Item 10.	Directors and Executive Officers of the Registrant.*	90
Item 11.	Executive Compensation.*	90
Item 12.	Security Ownership of Certain Beneficial Owners and Management.*	90
Item 13.	Certain Relationships and Related Transactions.*	90
Item 14.	Principal Accounting Fees and Services.*	90
PART IV.		91
Item 15.	Exhibits and Financial Statement Schedules.	91
PART V.		95

Real Estate Note		Corporate Credit Note
· 70 to 75% of loan amount · Senior claim on real estate · Junior claim on rents in bankruptcy · 10-year term, balloon at maturity · Significant debt service coverage and loan-to-value ratio		· 15 to 20% of loan amount · Junior claim on real estate · Senior claim on rents in bankruptcy · 10-year term, fully amortizing · Provides diversity and favorable yield when placed in a CDO

												(in thousands)⁽²⁾
														As of 12/31/04
Tenant or Guarantor	Location		Ratings (S&P/ Moody’s)⁽¹⁾		Business Category	Square Feet	Property Type	Coupon		Lease Expiration	Loan Maturity	Original Principal Balance		Principal Balance		Book Value		Loan to Realty Value⁽³⁾
Long-Term Credit Tenant Loans
Autozone, Inc.	Douglas, GA / Valdosta, GA⁽⁴	⁾	BBB+/Baa2		Auto Parts Store	13,383	Retail Store	6.50	%	6/2023 / 4/2024	11/2022	$	2,108	$	2,103	$	2,103	78	%
Best Buy Co., Inc..	Chicago, IL		BBB-/Baa3		Retail	45,720	Retail Store	6.43	%	3/2025	3/2025		17,609		17,609		17,609	91	%
City of Jasper, TX	Jasper, TX		NR/Baa3		Office	12,750	Office	7.00	%	12/2024	11/2024		1,736		1,736		1,681	87	%
CVS Corporation	Asheville, NC		A-/A3		Retail Drug	10,880	Retail Store	6.53	%	1/2026	1/2026		2,360		2,336		2,405	91	%
CVS Corporation	Athol, MA		A-/A3		Retail Drug	13,013	Retail Store	6.46	%	1/2025	1/2025		1,502		1,501		1,501	79	%
CVS Corporation	Bangor, PA		A-/A3		Retail Drug	13,013	Retail Store	6.28	%	1/2026	1/2026		2,521		2,472		2,426	88	%
CVS Corporation	Bluefield, WV		A-/A3		Retail Drug	10,125	Retail Store	8.00	%	1/2021	1/2021		1,439		1,354		1,493	80	%
CVS Corporation	Oak Ridge, NC		A-/A3		Retail Drug	10,880	Retail Store	6.99	%	1/2025	8/2024		3,243		3,224		3,224	83	%
CVS Corporation	Sunbury, PA		A-/A3		Retail Drug	10,125	Retail Store	7.50	%	1/2021	1/2021		1,829		1,699		1,654	81	%
CVS Corporation	Washington, DC		A-/A3		Retail Drug	7,920	Retail Store	8.10	%	1/2023	1/2023		2,781		2,569		2,760	78	%
Home Depot U.S.A., Inc.	Tullytown, PA		Private⁽⁵	⁾	Retail	116,016	Retail Store	6.62	%	1/2033	1/2033		8,447		8,444		8,444	98	%
Home Depot U.S.A., Inc.	Westminster, CO		Private⁽⁵	⁾	Retail	107,400	Retail Store	7.50	%	7/2018	5/2009		8,500		8,581		8,581	97	%
Kohl’s Corporation	Chicago, IL		A-/A3		Retail	133,000	Retail Store	6.69	%	9/2030	9/2030		48,270		48,270		48,270	94	%
Koninklijke Ahold n.v.	North Kingstown, RI		BB/Ba3		Retail Grocer	125,772	Retail Store	7.50	%	11/2025	11/2025		6,794		6,693		6,671	74	%
Koninklijke Ahold n.v.	Tewksbury, MA		BB/Ba3		Retail Grocer	58,450	Retail Store	7.50	%	1/2027	1/2027		6,625		6,572		6,567	74	%
Koninklijke Ahold n.v.	Upper Darby, PA		BB/Ba3		Retail Grocer	54,800	Retail Store	7.29	%	4/2024	4/2024		6,889		6,799		6,475	93	%
Lowe’s Companies, Inc	Matamoras, PA		A+/A2		Retail	162,070	Retail Store	6.61	%	5/2030	5/2030		7,208		7,196		7,196	96	%
National City Bank of the Midwest (f/k/a National City Bank of Michigan/Illinois)	Chicago, IL		A+/Aa3		Bank Branch	5,274	Bank Branch	5.89	%	12/2024	12/2024		3,114		3,114		3,202	78	%
Neiman Marcus Group, Inc	Las Vegas, NV		BBB/Baa2		Retail	167,000	Retail Store	6.06	%	11/2022	11/2021		8,267		7,900		8,602	83	%
United States Postal Service	Sammon Bay, AK		Private⁽⁶	⁾	Post Office	2,080	Post Office	7.05	%	10/2021	10/2021		1,015		986		1,008	76	%
University of Connecticut Health Center	Farmington, CT		AA/Aa3⁽⁷	⁾	Medical	100,000	Medical Office	6.34	%	11/2029	11/2024		22,800		22,752		23,667	91	%
Walgreen Co.	Dallas, TX⁽⁸	⁾	A+/Aa3		Retail Drug	14,550	Retail Store	6.46	%	12/2029	12/2029		2,718		2,718		2,718	63	%
													167,775		166,628		168,258

Corporate Credit Notes
Albertson’s, Inc.	Los Angeles, CA	BBB/Baa2		Retail Drug	16,475	Retail Store	6.50	%		7/2028	9/2013		437		398		354	85	%
Albertson’s, Inc.	Norwalk, CA	BBB/Baa2		Retail Drug	14,696	Retail Store	6.33	%		12/2028	12/2013		470		436		430	76	%
Best Buy Co., Inc	Olathe, KS	BBB-/Baa3		Retail - Elect.	48,744	Retail Store	5.40	%		1/2018	6/2013		1,779		1,595		1,512	86	%
Best Buy Co., Inc	Wichita Falls, TX	BBB-/Baa3		Retail - Elect.	30,038	Retail Store	6.15	%		1/2017	11/2012		743		631		593	81	%
CVS Corporation	Clemmons, NC	A-/A3		Retail Drug	10,880	Retail Store	5.54	%		1/2022	1/2015		285		285		271	66	%
CVS Corporation	Commerce, MI	A-/A3		Retail Drug	10,880	Retail Store	5.85	%		4/2025	5/2013		501		448		429	89	%
CVS Corporation	Garwood, NJ	A-/A3		Retail Drug	11,970	Retail Store	6.12	%		6/2025	8/2013		879		791		764	87	%
CVS Corporation	Kennett Square, PA	A-/A3		Retail Drug	12,150	Retail Store	6.40	%		1/2025	10/2012		857		716		685	90	%
CVS Corporation	Knox, IN	A-/A3		Retail Drug	10,125	Retail Store	7.60	%		1/2024	12/2011		322		250		249	75	%
CVS Corporation	Rockingham, NC	A-/A3		Retail Drug	10,125	Retail Store	6.12	%		1/2025	10/2013		435		397		386	82	%
CVS Corporation	Rutherford College, NC	A-/A3		Retail Drug	10,125	Retail Store	6.12	%		1/2025	10/2013		346		321		312	83	%
FedEx Ground Package System, Inc.	McCook, IL	Private⁽⁹	⁾	Distribution/ Whse/Office	159,699	Distribution/ Whse/Office	5.89	%		1/2019	2/2015		2,737		2,737		2,699	86	%
FedEx Ground Package System, Inc.	Reno, NV	Private⁽⁹	⁾	Distribution/ Whse/Office	106,396	Distribution/ Whse/Office	5.90	%		9/2018	10/2014		1,374		1,357		1,341	81	%
PerkinElmer, Inc.	Beltsville, MD	BB+/Ba2		Global Tech.	65,862	Light Industrial	7.35	%		11/2021	12/2011		707		547		542	86	%
PerkinElmer, Inc.	Daytona, FL	BB+/Ba2		Global Tech.	34,196	Light Industrial	7.35	%		11/2021	12/2011		321		248		246	82	%
PerkinElmer, Inc.	Phelps, NY	BB+/Ba2		Global Tech.	32,700	Light Industrial	7.35	%		11/2021	12/2011		299		231		225	90	%
PerkinElmer, Inc.	Warwick, RI	BB+/Ba2		Global Tech.	95,720	Light Industrial	7.68	%		12/2021	1/2012		939		735		716	87	%
Staples, Inc.	Odessa, TX	BBB-/Baa2		Office Supp.	23,942	Retail Store	6.41	%		6/2015	9/2012		408		342		321	84	%
Walgreen Co.	Delray Beach, FL	A+/Aa3		Retail Drug	15,120	Retail Store	6.20	%		1/2021	1/2013		595		508		505	79	%
Walgreen Co.	Riverside, CA	A+/Aa3		Retail Drug	12,804	Retail Store	6.10	%		10/2028	12/2013		571		529		515	77	%
Walgreen Co.	Waterford, MI	A+/Aa3		Retail Drug	14,490	Retail Store	5.50	%		1/2023	6/2013		953		842		780	87	%
													15,958		14,342		13,872

Recapitalized Loans
Natural Gas Pipeline Company of America	Oak Brook, IL	Private⁽⁹⁾		Natural Gas Transport. & Storage	201,189	Office	5.97	%		5/2008	6/2007		15,244		11,724		11,724	47	%
Xerox Corporation	El Segundo, CA	BB-/B1		Office	330,266	Office	4.71	%	⁽¹⁰⁾	11/2007	11/2007		16,483		13,202		13,202	27	%
													31,727		24,926		24,926

Totals												$	215,460	$	205,896	$	207,056

			By Segment
	Total		Lending Investments		Operating Net Lease Real Estate
Bondable net leases		13		13		—
Triple net leases		16		13		3
Double net leases		26		23		3
Modified gross leases		2		—		2
		57		49		8

	Lending Investments		Operating Net Lease Real Estate		Corporate/ Unallocated			Total
	(in thousands)
Total revenue	$	14,045	$	6,356	$	603		$	21,004
Net income (loss)		10,476		2,150		(11,266	)		1,360

	Balance as of 12/31/04
	(in thousands)
Owned Properties	$	194,541
Mortgage Loans		206,510	(1)
Development Loans		837
Structured Interests		87,756
Structuring Fees		4,426
Total	$	494,070

				(in thousands)⁽¹⁾
Security Description	CUSIP No.	Ratings (S&P or Fitch)		Face Amount		Cost		Carry Value	Coupon		Yield⁽²⁾
Investments in Commercial Mortgage Loan Securitizations⁽³⁾
BSCMS 1999-CLF1, Class E	07383FCC0	BB	$	3,326	$	2,034	$	2,512	7.11	%	10.31	%
BSCMS 1999-CLF1, Class F	07383FCD8	B-		2,494		1,019		1,019	7.11	%	19.00	%
CALFS 1997-CTL1, Class D	140281AF3	BBB-		3,000		2,903		2,951	6.16	%	6.42	%
CMLBC 2001-CMLB-1, Class E	201736AJ4	BBB+		9,526		10,108		11,375	7.88	%	6.14	%
CMLBC 2001-CMLB-1, Class G	201736AL9	BBB-		9,526		8,760		10,825	7.88	%	6.66	%
CMLBC 2001-CMLB-1, Class H	201736AM7	BB-		11,907		6,343		8,000	6.25	%	10.32	%
CMLBC 2001-CMLB-1, Class J	201736AN5	B-		7,144		3,024		3,388	6.25	%	14.58	%
CMLBC 2001-CMLB-1, Class K	201736AP0	NR		4,766		1,089		1,089	6.25	%	29.00	%
NLFC 1999-LTL-1, Class D	63859CCK7	BBB		5,000		3,251		5,117	6.45	%	6.27	%
NLFC 1999-LTL-1, Class E	63859CCL5	BB-		11,081		4,964		6,555	5.00	%	10.25	%
NLFC 1999-LTL-1, Class IO	63859CCG6	AAA		9,908		9,908		10,164	0.50	%	8.51	%
Other	Various	BBB		914		682		626	None		11.64	%⁽⁴⁾

Investments in Certificated Loan Transactions⁽⁵⁾
Yahoo, Inc.	984332AC0	BB+		16,999		16,495		17,169	6.65	%	6.34	%
CVS Corporation.	94999ABV4	A-		6,180		6,966		6,966	8.26	%	6.68	%

Totals			$	101,771	$	77,547	$	87,756

	Mortgage Loans	Structured Interests
	(in thousands, except interest rate data)

Unpaid Borrowings	$102,288	$31,543
Face Amount of Collateral	$136,477	$41,130
Scheduled Interest Rate on Assets Financed	One-month LIBOR plus .95%	One-month LIBOR plus .40%-.95%
Weighted Average Interest Rate on Assets Financed	3.34%	3.02%

Class of Notes	Principal Amount/Face Amount as of Closing Date		Percentage of all Securities			Ratings Moody’s/S&P		Stated Maturity		Stated Coupon Rate
A	$	252,000,000		84.0	%		Aaa/AAA		January 2040		4.926	%
B		16,500,000		5.5	%		Aa2/AA		January 2040		5.036	%
C		9,000,000		3.0	%		A2/A-		January 2040		5.406	%
D		4,500,000		1.5	%		Baa2/BBB		January 2040		6.206	%
E		3,000,000		1.0	%		Baa3/ BBB-		January 2040		6.606	%
	$	285,000,000

Asset Type	Face Value		Percentage
Long-term credit tenant loans	$	199,148,746		66.53	%
Corporate credit notes		23,893,987		7.98	%
Structured interests in net lease assets		61,285,399		20.48	%
Mezzanine loan		15,000,000		5.01	%
	$	299,328,132		100.00	%

Fiscal Year 2004	Low		High
March 19-March 31, 2004	$	12.50	$	13.50
Second Quarter		9.57		13.04
Third Quarter		9.10		11.70
Fourth Quarter		10.62		12.92

Quarter Ended	Dividend Payment Date		Dividend per Share
September 30, 2004		October 15, 2004		$	0.10
December 31, 2004		January 14, 2005			0.15
March 31, 2005		April 15, 2005			0.18

	Year ended December 31,
	2004			2003			2002			2001			2000
	(in thousands, except per share amounts)
*Statement of operations data*
Revenues:
Interest income from mortgage loans and securities	$	13,589		$	7,317		$	8,092		$	9,313		$	15,480
Gain-on-sales of mortgage loans and securities		794			11,652			10,051			21,565			2,106
Rental revenue		4,287			—			—			—			264
Property expense recoveries		1,608			—			—			—			—
Other revenue		726			151			343			321			57
Total revenues		21,004			19,120			18,486			31,199			17,907
Expenses:
Interest expense		2,768			1,220			2,142			5,882			13,247
Interest expense to affiliates		—			838			659			1,273			442
Property expenses		1,761			—			—			—			—
Net loss on derivatives and short sales of securities		724			3,129			7,729			11,954			11,985
Loss on securities		247			—			—			—			—
Provision for loss on mortgage loans		—			—			—			—			2,000
Impairment on investment in Bedford		—			—			—			—			1,669
General and administrative expenses		8,833			7,186			6,966			7,794			7,372
General and administrative expenses - stock based compensation		3,825			—			—			—			—
Depreciation and amortization expense on real property		1,281			—			—			—			—
Loan processing expenses		196			114			158			232			153
Total expenses		19,635			12,487			17,654			27,135			36,868
Income (loss) before provision for income taxes		1,369			6,633			832			4,064			(18,961	)
Provision for income taxes		9			—			—			—			—
Net income (loss)	$	1,360		$	6,633		$	832		$	4,064		$	(18,961	)

Earnings per share (pro forma for all years other than 2004):
Net income (loss) per share, basic and diluted	$	0.06		$	1.61		$	0.20		$	0.99		$	(4.62	)
Weighted average number of shares outstanding, basic and diluted		22,125			4,108			4,108			4,108			4,108
Dividends declared per share	$	0.25		$	—		$	—		$	—		$	—

*Other data*
Cash flows from operating activities	$	10,716		$	(10,743	)	$	3,774		$	234,057		$	(172,227	)
Cash flows from investing activities		(349,656	)		(69	)		846			(1,084	)		36
Cash flows from financing activities		363,139			11,948			(10,773	)		(224,265	)		169,771

	As of December 31,
	2004		2003		2002		2001		2000
	(in thousands)
*Balance sheet* *data*
Cash and cash equivalents	$	30,721	$	6,522	$	5,386	$	11,539	$	2,831
Securities available for sale		87,756		40,054		20,348		13,963		20,342
Structuring fees receivable		4,426		5,223		4,794		5,231		111
Mortgage loans held for sale		—		71,757		77,716		83,883		311,919
Mortgage loans held for investment		207,347		—		—		—		—
Real estate investments, net		194,541		—		—		—		—
Real estate investments consolidated under FIN 46		48,000		—		—		—		—
Total assets		581,702		125,773		112,276		129,473		444,077
Repurchase agreement obligations		133,831		88,087		76,116		86,658		304,692
Mortgages on real estate investments		111,539		—		—		—		—
Stockholders’ equity/members’ capital		253,264		34,045		27,775		25,066		5,428

				As of December 31, 2004 (in thousands)
Securitization	Classes Owned	Nature of Exposure	2004 Asset Write-downs	Aggregate Face Amount	Aggregate Carry Value
BSCMS 1999-CLF1	E and F	Loans on two properties with an aggregate current unpaid principal balance of approximately $7.9 million. Winn-Dixie has rejected one of the underlying leases, and the loan on that property has a current unpaid principal balance of $3.8 million. The securitization trust includes an expense reserve account of approximately $0.40 million as of February 2005, that can be utilized by bond holders for realized losses. The expense reserve account is funded monthly at a rate of approximately $6,000. At the expected maturity of the securitization trust, we expect the reserve account to be further funded by a total of approximately $1.1 million (assuming a zero percent reinvestment rate).	$0.25 million write-down of Class F security.	$5,820	$3,531
CMLBC 2001- CMLB-1	E, G, H, J and K	$22.4 million pass-through trust certificate with exposure to 14 Winn-Dixie warehouse/distribution and/or manufacturing facilities and the Winn-Dixie headquarters building. Winn-Dixie has announced its intention to close two of the warehouses. The remaining certificate balances of all classes in the trust aggregate approximately $370.1 million. All classes in the pass-through trust share losses on a pro rata basis. We estimate that for every dollar of loss incurred by the pass through trust, we would incur a loss of approximately $0.014 on the carry value of our securities. Loan on one property with a current aggregate unpaid principal balance of approximately $3.3 million.	None; however, we determined not to write up our investment despite our receipt of a higher market quote at year-end.	$42,869	$34,677
CALFS 1997-CTL-1	D	Loans on two properties with a current aggregate unpaid principal balance of approximately $6.4 million.	None.	$3,000	$2,951

	Lending Investments		Operating Net Lease Real Estate		Corporate/ Unallocated			Total
	(in thousands)

Total revenue	$	14,045	$	6,356	$	603		$	21,004
Total expenses		3,569		4,206		11,869			19,644
Net income (loss)		10,476		2,150		(11,266	)		1,360
Total assets		302,923		247,325		31,454			581,702

	2004
	Total		Per Share(1)
	(in thousands, except per share amounts)

Net income	$	1,360	$	0.06
Adjustments:
Add: Depreciation and amortization expense on real property		1,281		0.06
Funds from operations	$	2,641	$	0.12

	Less than 1 year		2-3 years		4-5 years		After 5 years		Total
Mortgage notes payable	$	1,159	$	2,959	$	6,055	$	101,366	$	111,539
Operating leases		569		241		—		—		810
Repurchase agreement obligations		133,831		—		—		—		133,831
Total	$	135,559	$	3,200	$	6,055	$	101,366	$	246,180

	Carrying Amount				Notional Amount				Weighted Average Effective Interest Rate			Maturity Date		Fair Value
	12/31/04		12/31/03		12/31/04		12/31/03		12/31/04			12/31/04		12/31/04		12/31/03
	(dollars in thousands)
Assets:
Mortgage loans held for investment(1)	$	207,893		—	$	206,735		—		6.56	%		Various	$	215,330		—
Mortgage loans held for sale(2)		—	$	71,973		—	$	72,370		—			—		—	$	73,208
Securities available for sale-CMBS(3)		87,756		40,054		101,771		55,873		9.79	%		2019-2028		87,756		40,054
Structuring fees receivable(3)		4,426		5,223		N/A		N/A		8.10	%		2010-2020		4,426		5,223
Derivative assets(4)		42		—		4,868		—		N/A			N/A		42		—

Liabilities:
Repurchase agreements(5)		133,831		88,087		133,831		88,087		3.26	%		Short term		133,831		88,087
Mortgage notes payable(6)		111,539		—		110,732		—		5.39	%		2013-2018		111,539		—
Derivative liabilities(4)		7,335		484		228,182		39,400		N/A			N/A		7,355		484

	Expected Maturity Dates
	2005		2006		2007		2008		2009		thereafter
	(in thousands, notional amounts where appropriate, otherwise carrying amounts)

Mortgage loans held for investment	$	10,939	$	13,409	$	13,393	$	4,552	$	13,487	$	150,955
Securities available for sale-CMBS		960		980		1,020		1,067		1,100		96,644
Structuring fees receivable		563		609		659		713		772		1,110
Derivative assets		42		—		—		—		—		—
Repurchase agreements		133,831		—		—		—		—		—
Mortgage notes payable		1,066		1,235		1,550		2,749		3,144		100,988
Derivative liabilities		7,355		—		—		—		—		—


Real Estate
Balance-January 1, 2004		$	-
Additions during the year:
Property Acquisitions	195,648
Cost Capitalized Subsequent to Acquisition	174

Balance-December 31, 2004		$	195,822

Accumulated Depreciation
Balance-January 1, 2004		$	-
Additions during the year:
Depreciation on property	1,281

Balance-December 31, 2004		$	(1,281	)


Balance-January 1, 2002			$	84,513
Additions during the year:
New mortgage loans	141,476
Reduction in valuation provision	83
Mark to fair value	100
Deductions during the year:
Principal received	(3,904	)
Loans sold	(144,276	)
Balance-December 31, 2002			$	77,992
Additions during the year:
New mortgage loans	143,566
Reduction in valuation provision	1,917
Mark to fair value	(857	)
Deductions during the year:
Principal received	(2,381	)
Loans sold	(148,264	)
Balance-December 31, 2003			$	71,973
Additions during the year:
New mortgage loans	167,009
Mark to fair value	(343	)
Fair value hedges allocated to unearned origination discounts and premiums	2,403
Deductions during the year:
Principal received	(8,521	)
Loans sold	(24,628	)
Balance-December 31, 2004			$	207,893

Exhibit No.	Description

3.1(1)	Articles of Amendment and Restatement of the registrant
3.2(1)	Amended and Restated Bylaws of the registrant
4.1(1)	Form of Certificate evidencing the Common Stock, par value $0.01 per share, of the registrant
10.1(2)	Purchase and Sale Agreement, dated January 31, 2000 between Capital Lease Funding, L.P., CLFC HPII Inc., CLF Holdings, Inc. and Bank of America, N.A. (Capital Lease Funding, L.P.’s interest was assigned to Capital Lease Funding, LLC on November 15, 2001)
10.2(2)	Call Option Agreement, dated January 31, 2000 between Bank of America, N.A., Capital Leasing Funding, L.P. and CLFC HPII Inc. (Capital Lease Funding, L.P.’s interest was assigned to Capital Lease Funding, LLC on November 15, 2001)
10.3(2)	Security Agreement, dated January 31, 2000 between Capital Lease Funding, L.P. and Bank of America, N.A. (Capital Lease Funding, L.P.’s interest was assigned to Capital Lease Funding, LLC on November 15, 2001)
10.4(2)	Loan Contribution Agreement, dated January 31, 2000 between Bank of America, N.A. and Capital Lease Funding, L.P. (Capital Lease Funding, L.P.’s interest was assigned to Capital Lease Funding, LLC on November 15, 2001)
10.5(2)	Amendment to Purchase and Sale Agreement, Call Option Agreement, Loan Contribution Agreement and Security Agreement, dated April 30, 2002 between Capital Lease Funding, LLC, CLFC HPII Inc. and Bank of America, N.A.
10.6(2)	Second Amendment to Purchase and Sale Agreement, Call Option Agreement, Loan Contribution Agreement and Security Agreement, dated February 28, 2003 between Capital Lease Funding, LLC, CLFC HPII Inc. and Bank of America, N.A.
10.7(3)	Third Amendment to Purchase and Sale Agreement, Call Option Agreement, Loan Contribution Agreement and Security Agreement, dated December 31, 2003 between Capital Lease Funding, LLC, CLFC HPII Inc. and Bank of America, N.A.
10.8(2)	Contribution Agreement, dated as of November 20, 2003 between the registrant, Hyperion CLF LLC, LSR Capital CLF LLC, Wachovia Affordable Housing Community Development Corporation, Wachovia Investors, Inc. and CLF Management I, LLC
10.9(2)	Registration Rights Agreement, dated as of November 20, 2003 between the registrant and Hyperion CLF LLC, LSR Capital CLF LLC and Wachovia Investors, Inc.
10.10(4)	Agreement of Purchase and Sale, dated July 14, 2004, between Caplease, LP and NEDA Puerto Rico, Inc.
10.11(4)	First amendment of Purchase and Sale, dated August 13, 2004, between Caplease, LP and NEDA Puerto Rico, Inc.
10.12(4)	Second amendment of Purchase and Sale, dated September 15, 2004, between Caplease, LP and NEDA Puerto Rico, Inc.
10.13(4)	Third amendment of Purchase and Sale, dated September 29, 2004, between CLF VA Ponce LLC and NEDA Puerto Rico, Inc.
10.14(4)	Fourth amendment of Purchase and Sale, dated October 6, 2004, between CLF VA Ponce LLC and NEDA Puerto Rico, Inc.
10.15(4)	Fifth amendment of Purchase and Sale, dated October 28, 2004, between CLF VA Ponce LLC and NEDA Puerto Rico, Inc.
10.16(5)	Agreement of Purchase and Sale, dated July 15, 2004, between Caplease, LP and 1000 Milwaukee Avenue Owner Corp.
10.17(6)	Master Repurchase Agreement, dated September 22, 2004 between the registrant, Wachovia Bank, National Association, Caplease, LP and Certain Special-Purpose Entity Subsidiaries thereof
10.18(7)	Promissory Note (Note A), dated October 28, 2004, of CLF 1000 Milwaukee Avenue LLC in favor of Wachovia Bank, National Association

10.19(7)	Promissory Note (Note B), dated October 28, 2004, of CLF 1000 Milwaukee Avenue LLC in favor of Caplease, LP
10.20(8)	Promissory Note, dated December 9, 2004, of the registrant in favor of Wachovia Bank, National Association
10.21(9)	Agreement of Purchase and Sale, dated December 23, 2004, between Caplease, LP and WXV/Whippany, LLC
*10.22	Form of Employment Agreement between each of Paul H. McDowell, William R. Pollert, Shawn P. Seale, Robert C. Blanz and Michael J. Heneghan, and the registrant
*10.23(10)	Capital Lease Funding, Inc. 2004 Stock Incentive Plan
*10.24(10)	Form of Non-Employee Director Restricted Stock Award Agreement
*10.25(10)	Form of Executive Officer Restricted Stock Agreement
10.26	Purchase and Sale Agreement dated as of October 22, 2004 between Caplease, LP and 10720-10750-10770 Columbia Pike Investors LLC
10.27	Contract of Sale dated as of November 1, 2004 between Caplease, LP and Hyperion Partners II L.P. (Portsmouth, VA)
10.28	Contract of Sale dated as of November 1, 2004 between Caplease, LP and Hyperion Partners II L.P. (Pennsauken, NJ)
10.29(11)	Promissory Note, dated February 25, 2005, of CLF Parsippany LLC in favor of Wachovia Bank, National Association
10.30(11)	Promissory Note, dated February 25, 2005, of CLF Parsippany LLC in favor of Caplease, LP
*10.31(11)	Summary of Compensation for the Chief Executive Officer and each of the Named Executive Officers for Fiscal 2005
*10.32(12)	Summary of Independent Director Compensation for Fiscal 2005
21.1	List of Subsidiaries
23.1	Consent of Ernst & Young LLP
31.1	Certification of Chief Executive Officer required by Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of the Chief Financial Officer required by Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of the registrant’s Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of the registrant’s Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*	Denotes compensatory plans or arrangement or management contracts required to be filed as exhibits to this Annual Report on Form 10-K.

(1)	Incorporated by reference from the registrant’s Amendment No. 4 to Registration Statement on Form S-11 filed with the Securities and Exchange Commission on March 8, 2004 (File No. 333-110644).

(2)	Incorporated by reference from the registrant’s Amendment No. 1 to Registration Statement on Form S-11 filed with the Securities and Exchange Commission on January 12, 2004 (File No. 333-110644).

(3)	Incorporated by reference from the registrant’s Amendment No. 2 to Registration Statement on Form S-11 filed with the Securities and Exchange Commission on February 13, 2004 (File No. 333-110644).

(4)	Incorporated by reference from the registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 5, 2004.

(5)	Incorporated by reference from the registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 3, 2004.

(6)	Incorporated by reference from the registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 24, 2004.


	CAPITAL LEASE FUNDING, INC.
	Registrant

Date: March 30, 2005	By:	/s/ Paul H. McDowell
		Paul H. McDowell
		Chief Executive Officer

Signature	Title	Date

/s/ Lewis S. Ranieri	Chairman of the Board	March 30, 2005
Lewis S. Ranieri	Chairman of the Board

/s/ Paul H. McDowell	Chief Executive Officer and Director (Principal Executive Officer)	March 30, 2005
Paul H. McDowell

/s/ William R. Pollert	President and Director	March 30, 2005
William R. Pollert	President and Director

/s/ Shawn P. Seale	Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)	March 30, 2005
Shawn P. Seale

/s/ Michael E. Gagliardi	Director	March 30, 2005
Michael E. Gagliardi	Director

/s/ Stanley Kreitman	Director	March 30, 2005
Stanley Kreitman	Director

/s/ Jeff F. Rogatz	Director	March 30, 2005
Jeff F. Rogatz	Director

/s/ Howard A. Silver	Director	March 30, 2005
Howard A. Silver	Director